Let's take a look at this mortgage subsidy plan.
Buyer A purchased a house for 200K. Buyer A purchased the house with a 0 money down mortgage in 2005. Buyer A received a first mortgage for 80% or 160K from Lender X, and a Second Mortgage for 20% or 40K from lender Y.
Let’s say Buyer A is currently paying 12% interest on the loan, around $2000/month mortgage, $1600 to Lender X and $400 to lender Y.
Let’s suppose this house has decreased in value 30% and is now worth 160K. (This is a typical scenario in South Florida, California & Nevada).
The reality is that Buyer A has a big problem. They are stuck paying 12% in today’s market where 6% mortgages are available to strong borrowers. However, Buyer A cannot refinance this loan because there is no equity in the house. Now let’s assume Buyer A doesn’t have the best credit and assume that Buyer A’s job is in jeopardy. Now the problem escalates. This is our current reality.
Lender X also has a big problem. Buyer A is unable to make the payments, and the house that used to be worth 200K is now only worth 160K. With mounting foreclosures in the neighborhood, this value of the house continues to decrease, and Lender A is faced with a difficult decision to reduce payments to allow Buyer A to stay in the house, or to foreclose on an asset (really a liability in this market), that has severely decreased in value.
Lender Y is really in big trouble. Their loan has effectively been wiped out as they lent on the last 20% of the house’s value in 2005, a value that is gone. This lender’s security has vanished into thin air!!! If you were Buyer A would you want to pay $400 a month for a piece of air??
Welcome to our housing crises…So, its rumored the government has come up with a plan to subsidize mortgages to make payments more affordable for Buyer A, so that they are able to stay in their house, avoid foreclosure, continue to pay their lenders, and in essence put an artificial floor in the housing market.
First, if I am not mistaking, there was talk of this plan during the Bush presidency too, and after some thought (instead of the knee jerk reaction in the market yesterday), while mortgage subsidies aim to slow and eventually halt the housing crises, the plan opens up MANY questions, and has many holes that I think will prove impossible to overcome.
Here are just a few:
- Is lender X willing to negotiate a reduced payment? Is lender Y?
- Is lender Y entitled to receive a payment on a worthless note?
- How will government determine which homeowners are entitled to such a program?
- Does buyer want to continue to pay for an asset that has lost its value and that may not regain its value for 7-10 years?
- Is the government willing to subsidize principal reductions on mortgages?? This opens up a whole new can of worms as far as contract law, and in my mind even threatens the essence of capitalism.
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